Puff Puff Pass the Inflation: Implications for the cannabis industry

With inflation at a 40-year high and the Fed announcing the most aggressive rate hikes in years, inflation and the uncertain economy dominates most conversations. Based on May’s sustained raise in the Consumer Price Index (CPI), consumers don’t expect to get much relief in the near future. However, the cannabis industry is significantly insulated from the rest of the US economy – so how will inflation impact cannabis market growth and consumer behavior?

What Causes Inflation

Professional economists spend entire careers debating the causes of inflation, from changes in production cost (cost-push), to increased demand (demand-pull), to changes in monetary policy. Right now the US economy is experiencing abnormal behavior in all three categories.

Global supply chain interruptions and labor shortages have caused elevated prices for everything from oil to processed chickens. Raw material prices are elevated, and thus the total cost of production is up.

Consumer demand is also fluctuating. With shortages of everyday products now relatively common, consumers sometimes over-purchase to compensate, inflaming the cost increase.

Since the start of the pandemic, government spending skyrocketed about 10 percentage points to become approximately 30% of national GDP. These policies result in a high supply of cash being injected into the market, which has the effect of increasing consumer demand and thus prices. Compounding this is the disruption in supplies, such as gas and wheat, from Russia and Ukraine.

Inflation and the Cannabis Industry

Due to the siloed nature of state markets, operators in some states are feeling the effects of inflation more acutely than operators in other states. For example, cultivators and manufacturers in states with the highest gas prices have to factor in even higher production and shipping costs than their counterparts in other states. These costs then get passed along to retailers, but retailers are hesitant to pass these costs along to consumers.

Also, cultivators grew much more flower in mature markets like Washington, Colorado and Oregon than what the manufacturers and retailers could absorb. Colorado growers report the price of flower dropping from $1,600 a pound to $800 a pound. Meanwhile, the cost of production is hovering at $800-$900 a pound, making it impossible for cultivators to turn any profit.

Without the boost of additional stimulus checks, consumer demand growth for cannabis products has started to fall back to normal levels. This is happening at the same time that the industry is seeing a glut of new brands and products in addition to the oversupply of flower. The staggering increase in supply has prompted retailers to offer promotions to shrink inventory and increase sales velocity of specific SKUs. Although this tactic works, it isn’t sustainable long-term.

However, many dispensaries are worried that marking up their products to allow for profitable margins will drive their customers to other retailers or even to the illicit market, which is able to significantly undercut legal prices. In fact, according to a recent study released by New Frontier Data, price is the third-most important factor to cannabis consumers when making a purchase.

Unlike products in the CPG industry, consumers don’t have to worry about the effects of “shrink-flation” on their favorite gummies, flower or vape pens because cannabis products are sold by weight or THC content. So, your bag of Doritos might come with five fewer chips than before, but at least you know you’re getting the same amount of cannabis you always have.

   

While it benefits consumers to see prices remain the same or even drop at their local dispensary, the same can’t be said for businesses in the cannabis industry. These operators are feeling squeezed from all sides. Some are reporting supplier costs increasing as much as 30%.

Suppliers are having to pass along the sharp increase in fuel and fertilizer prices caused by the war in Ukraine. Not only is Russia one of the top producers of fuel in the world, it is also one of the top producers of fertilizer. The impact of this disruption is felt across all types of agriculture – including cannabis cultivators.

Additionally, employees are demanding better treatment from their employers: better benefits, higher compensation, and more manageable workloads. This leads to increased payroll costs, which businesses in most industries can write off of their taxes. However, until there is meaningful tax reform or federal legalization, the cannabis industry will be disproportionately affected by these payroll increases because Section 280E prevents the cannabis industry from deducting business expenses from their taxes.

Strategies to Overcome Market Conditions

This uncertain business environment requires owners to get creative in order to boost sales and cut costs. What might this look like?

Continued focus on automation, digitization, and streamlining of processes
The pandemic advanced automation and digital adoption of many formerly manual processes across all industries. Improving your cash management and inventory management procedures will lead to valuable savings in time and money. Additionally, encourage cashless payments because cashless tickets are 25% larger than cash tickets on average.

Empowering budtenders
Ensure your budtenders are properly empowered with the talking points they need to address customer questions and concerns. If something is out of stock, budtenders can give a good explanation as to why while also recommending an alternative so that your dispensary doesn’t miss out on a sale.

Changes in hardware and packaging materials
Although certain aspects of packaging are dictated by state regulations, brands and retailers might begin opting for more affordable packaging to improve margins. Perhaps they choose child-proof plastic packaging rather than tinted glass containers that do a better job of protecting flower from UV rays. Or, perhaps a vape pen manufacturer decides to substitute a less expensive shell because it’s in stock versus their preferred shell that’s been backordered for months.

Layoffs, hiring freezes and more demands on employees
The most recent layoffs in the industry have mostly been cannabis tech companies. If market conditions do not improve soon, there is a good chance other types of operators and ancillaries will also have to implement layoffs or hiring freezes to remain solvent. This consolidation will cause owners and the remaining employees to absorb the workload.

Experimenting with new pricing strategies and buyer psychology
If sales are stagnant or if you want to take your game to the next level, it could be time to turn your sales floor into a laboratory of sorts. Change up how items are shelved. Display them in groups differently than before. Test out new signage. There are several helpful guides to dispensary retail pricing strategies, so pick your favorite and get to testing!

The current market contraction and ongoing supply chain issues are producing significant headwinds that operators must overcome to remain in business. However, no one got into the cannabis industry because they were complacent, risk-averse, or inside-the-box-thinkers. The same resiliency, passion, drive, creativity, and innovation that inspired us to get into the cannabis industry is what is going to get us through these challenges